Here’s Everything You Need To Know About Personal Loan Prepayment – Forbes Advisor

By on September 16, 2021 0

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So you have a personal loan and you are now in a better financial situation. You might even have enough money to start paying off your personal loan sooner.

But before you start sending these additional payments, there are a few things you need to think about first. While it’s always a good idea to pay off debt quickly, there could be even better uses for that extra cash depending on your situation. And depending on your goals and how your loan is structured, it might actually be beneficial to keep it for the duration.

Here are the main points to consider when deciding to repay your personal loan early.

Can you pay off your personal loans sooner?

Yes, you can usually still prepay a personal loan. However, this can come at a cost depending on your lender. While most personal lenders don’t charge you to prepay your loan, some may impose a prepayment penalty if you pay off your loan earlier than expected.

Prepayment penalties typically start at around 2% of the outstanding balance if you pay off your loan in the first year after you apply and qualify. The penalties then decrease for each subsequent year of a loan until they reach zero.

If you plan to prepay your loan, check your loan documents or call your lender to make sure they aren’t charging prepayment penalties before sending additional money.

When to pay off a loan sooner

If you have the extra cash, paying off your debt can help your finances no matter what type of loan you have. However, it is also true that your extra money could be more useful elsewhere as well.

Before you prepay a loan, it’s a good idea to make sure you have an emergency fund. This is because if you send your extra money and disaster strikes you may have to go into debt again and you will be back to square one. Nobody wants that.

If you have an emergency fund in place, take a look at your other types of debt, especially their interest rates. Credit cards, for example, often have higher interest rates, so it may be beneficial to pay off that debt first with your extra money.

Finally, think about your long-term goals and what you could earn if you invested that money instead. If your personal loan charges a higher interest rate than what you could earn if you invested the money elsewhere, it’s usually a pretty safe bet to pay off your personal loan. But if you could make more money in another investment, like an index fund, it might be better to mix your money there because you will earn more than what you pay in interest on your personal loan.

Related: Personal loan calculator: Estimate your payments

Benefits of early repayment of personal loans

Repaying your personal loan has many advantages, including:

  • Save money on interest
  • Lower your debt-to-income ratio (DTI)
  • Eliminate the stress of owing money
  • Pay off your debts and get rid of your monthly payments sooner

Disadvantages of early repayment of a personal loan

Here are some of the disadvantages of prepaying your personal loan:

  • May reduce your chances of creating credit
  • Additional payments could have been used to save or invest
  • You may have to pay a prepayment penalty

Is prepaying a loan bad for your credit?

It sounds a bit cruel – you’ve demonstrated good credit habits by not only paying off your loan on time, but paying it off sooner. Shouldn’t you be rewarded with a better credit score?

Unfortunately, it’s not always that clear. You generally won’t see much of an impact on your credit score. Instead, a bit more of a concern is that you won’t have as many opportunities to build credit. The more on-time payments you can get on your credit report (especially if you’ve already made late payments), the more it will help your credit score.

If you pay off the personal loan early, you lose the ability to make those payments on time. (On the flip side, you’re also removing the possibility of making late payments, which would have an even bigger negative impact on your credit score.)

Additionally, once you have paid off your personal loan, it will be marked as a closed account in good standing on your credit report, assuming all of your payments were made on time. If so, it will stay on your credit report for another 10 years. This will continue to improve your credit score, but not as much as when it was with an open account (i.e. if you were still paying it off).

If you pay off your personal loan three years earlier, for example, that means it will disappear from your credit report three years sooner, and it won’t improve your credit score at all.

Final result

When it comes to prepaying your personal loan or not, it’s usually about the best and the best. Both options are good, but one can be better than the other. If you’ve received additional cash, paying off your personal loan will usually come in handy. But whether that’s the best use of your money is a whole other consideration.

If you’re the type of person who doesn’t like the idea of ​​going into debt and already has an emergency fund, you might be better off paying off your personal loan. On the other hand, if you are more concerned with building credit and think you can find a better use of that money elsewhere, then choose by all means to hold onto that debt a little longer by continuing to perform. minimum payments.

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